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Taxes


For a few years, a ring of criminals believed by the U.S. government to be based in India have been involved in a pervasive tax scam. Callers impersonate IRS officials, connect with American taxpayers, and convince many that they have an outstanding bill for tax payments.

The scam has been so pervasive that it has generated more than $15 million from panicked taxpayers.

CNN offers a story from a recent victim of the scam:

One of those victims was former NFL player Frank Garcia, who is now a sports radio host in Charlotte, North Carolina. When he got the call, it sounded so authentic, he left the radio station in a panic, scramming to get the money they wanted.

“The only thing running through my head is, I’m going to jail. I’m gonna be on television, in handcuffs, for tax evasion,” he recalled. “I had to follow specific steps not to be arrested. That the authorities had been contacted and in fact, they are on the way and will be there in 30 minutes.”

Garcia says he spent five hours driving to various stores around Charlotte, depositing $500 each time into a PayPal account set up by the woman on the phone. He ended up losing about $4,000.

Public figures tend to be more anxious than most people about being guilty of a crime. The destruction of a career in the public eye and a happy life is easy given the public taste for scandal and the American system of justice through trial by media.

And when you believe you might be in major trouble, the ability to think rationally sometimes disappears. To a reader, the idea that the IRS would have a PayPal account to collect past due tax bills sounds fishy, if not ridiculous. But in the heat of the moment, when you’re being threatened with jail time, you just want to problem to go away, and all possible resolutions sound legitimate.

the prevalence of media warnings about the scam has certainly helped slow down the perpetrators’ attack on taxpayers. I’ve even seen warnings on my local news broadcasts (but it probably won’t be totally effective and pervasive until reality show producers incorporate scam warnings into their shows).

Money offers a few tips, summarized below, for preventing yourself from being a victim of this scam, so while knowledge does help, as I’ve already mentioned, under stress logical reasoning often fails.

Scammers spoof caller I.D. The call may be coming from somewhere on the other side of the world, but the caller I.D. might say it’s coming from a number with a 202 area code (Washington, D.C.).

In reality, the IRS does not call taxpayers, and the organization especially doesn’t call taxpayers to inform them of an overdue tax bill. If a taxpayer truthfully owes tax, the IRS sends a bill, and offers instructions for the taxpayer to respond.

But I get how people can fall for this. Sometimes the U.S. Postal Service isn’t reliable. Sometimes you accidentally discard legitimate mail, mistaking it for junk mail. A caller can easily convince someone that they had sent notices through the mail which, from their perspective, were ignored.

Scammers ask for immediate payment. The real IRS doesn’t ask for payment over the phone, and are not in the business of setting up PayPal accounts to receive the funds or of instructing taxpayers to purchase prepaid debit cards. The IRS takes personal checks sent to official addresses and electronic payments through a government gateway, the Electronic Federal Tax Payment System (EFTPS) or DirectPay. That’s it.

This fact doesn’t change for taxes owed from previous years, even if you settle with the IRS for a lesser amount.

Even to taxpayers falling for the scam, it sounds like the callers are working somewhat outside the “system,” especially when they agree to settle. So an alternative form of payment might not raise any red flags.

Scammers threaten to arrest or deport their victims. The IRS wouldn’t do that. But it’s hard to believe this is not an IRS tactic when we know from media reports that tax evasion is a crime that results in arrest and deportation. If the scammers make victims believe that they could be guilty of tax evasion, the fear of being arrested is in their mind before the scammers “confirm” that will be the result of failing to pay.

And if you happen to be an immigrant fearing deportation, either because you are in the country illegally or believe it’s easy to be mistaken for someone in the country illegally, the threat of deportation could be so frightening (especially if you are escaping a dangerous home country) that you’re willing to do anything to remain in the United States.

Here’s what happens when you really do owe back taxes.

First, if you earn a paycheck from an employer and haven’t filed your taxes, the IRS will eventually catch on, and you will be expected to pay what you owe if you haven’t already through paycheck withholding. If you have paid taxes every year you owe taxes, but haven’t paid enough, you will still be expected to pay the remainder of what you owe.

The IRS will send you a notice in the form of a bill, identifying how much the government believes you owe and give you a deadline to pay. You will owe penalties and interest beginning with the date that tax payment was due, and that will be included on the bill.

If you disagree with the IRS assessment, you can call the IRS at 800-829-1040 to discuss the matter. But if you do owe the money, you will have to come up with some solution to pay. That solution could be paying immediately, as the IRS requests, agreeing to an installment plan, where you can pay the taxes over a period of time, or coming up with an offer in compromise.

The offer in compromise is available to people with a financial hardship, but the IRS must determine it would never be able to receive the full amount of tax owed.

If none of the above can resolve the issue, the IRS can resort to filing a federal tax lien, a legal claim to your property. The IRS may issue a levy, seizing your wages or bank accounts. These can continue until your tax bill is paid in full or the IRS can no longer legally seek repayment. You can lose your house, your retirement funds, and your income.

Because these consequences are so dire, it’s understandable that people are on edge when they receive a call purportedly from the IRS and therefore vulnerable to this widespread and successful scam.

Have you received one of these calls from someone claiming to be from the IRS? What happened on the phone call?

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There’s some good news for American taxpayers this year. First of all, it was recently announced that President Obama would not seek a reduction in tax benefits for those who invest in 529 plans for saving for their kids’ education. Even though it is the wealthy who benefit from this tax break, it is still represents a potential for middle class tax savings, and a reduction in benefit was a bad idea.

401(k) plans are the primary retirement savings vehicle for the middle class, particularly as more employers enroll new employees automatically in the plans. And for those who have the ability to maximize their contribution each year, the new calendar year offers an additional opportunity.

In 2014, the IRS did not adjust the maximum contribution from the previous year. But this year, the maximum contribution to retirement accounts, which include 401(k) accounts, 403(b) accounts, most 457 plans, and Thrift Savings Plans, will be $18,000, up $500 from $17,500.

Savers and investors aged 50 or older can take advantage of a catch-up contribution, effectively increasing the limit for those approaching traditional retirement age. In 2015, taxpayers who meet this age-based criterion can contribute an additional $6,000 above the regular maximum of $18,000. As a result, if you are 50 or older, you can contribute a maximum of $24,000 into these tax-advantaged accounts. That’s up from a total of $23,000 in 2014.

The total contribution limit, including employer contributions, has increased from $52,000 to $53,000.

The benefits of a 401(k) plan are designed to be directed primarily at people who most need an incentive to save for retirement. This may help contain the tax benefits within the middle class. The government does this by applying a maximum level of compensation to which matching benefits apply. In 2015, only the first $265,000 in an employee’s compensation over the course of 2015 may be applied to the company’s matching formula. That income limit has grown from $260,000 in 2014. That’s a sufficiently high maximum and should cover more than just the middle class.

To illustrate, if a company matches an employee’s contributions at a rate of 50% up to a limit of 5% the salary, an employee with a $100,000 salary deferring $15,000 will receive at most a $5,000 matching contribution (5% of the full $100,000 salary). If an employee at the same company ears $400,000 in compensation throughout the year, deferring $15,000, the matching contribution will be $13,250 (5% of the $265,000 maximum compensation, not $20,000). There are additional rules in place that require a company to balance benefits between highly compensated employees (those earning $120,000 or more) and all others.

In 2013, new regulations required 401(k) plan administers to explicitly state in quarterly statements how much investors are paying in fees. Previously, this information was not easy to discover. While you could (and should) look at the various prospectuses in search of management expenses fees or expense ratios, expressed as a percentage of assets, there were at least two obstacles:

  • The expense ratios force you to do your own calculations to determine how much money you’re spending in fees.
  • Not all fees are included in expense ratios. Some funds, like annuity-based mutual funds, don’t have expense ratios but certainly have fees.

To maximize your 401(k) contribution in 2015, spread the $18,000 across the number of paychecks you plan to receive throughout the year. That’s a contribution of $1,500 each month, $750 twice a month, $692 every two weeks, or $346 a week for those age 49 or younger. The calculation for those over 50 who want to max the contribution are $2,000 per month, $1,000 twice a month, $923 every two weeks, or $461 a week.

If your contributions are recorded in the form of percentages, don’t forget to change your contribution to take into account raises and bonuses. If you are expecting your company to match your contributions at some level, if you reach your 401(k) contribution limit before your last paycheck, you may miss out on free money.

Here’s a quick overview of my experience with 401(k) accounts over the past few years, over which time I was employed by a large company in the financial sector, I left that job to work for myself full-time, I sold a business and collected proceeds as income for a few years, and am now back to earning only self-employment income.

Last year, I had the option to contribute part of my self-employment income into an Individual 401(k) plans or a SEP IRA, but I did not do so. Theoretically, I can still choose to invest in a SEP IRA for 2014, so as I prepare my tax return, I’ll determine whether this will be beneficial or not.

In 2013, I was purely self-employed, and with still receiving income as a result of the sale of an asset with installation payments, I won’t qualify for a tax-advantaged retirement plan.

In 2012, I was for about half the year an employee of a company, during which time I faithfully contributed a portion of my income to a 401(k). For the remainder of the year, I have been and will continue to operate this web site as a consultant for that company, and I have not been contributing to a tax-advantaged retirement plan during that time. Assuming no financial tragedies and modest desires, my retirement needs are met, though I’m not sure what I want my retirement to look like.

In 2011, I worked fully for myself. Without an employer, I had no access to a regular 401(k), but I did initiate an Individual 401(k), which follows the same rules. By the end of the year, I expect to have maximized the employee portion of my 401(k) contributions at $16,500 with extra invested for the employer portion.

My 2010 contributions fell short from the maximum by about $700, and a portion of that is due to leaving the company in the middle of December. I received the full company match, a 100% match on the first 4% of my salary that was contributed to the plan, in every pay period.

In 2009, I contributed the maximum $16,500, but I didn’t plan for an extra paycheck at the end of the year, so that last paycheck did not include a contribution to my 401(k). As a result my imperfect calculation, I missed out on a portion of my employer’s matching contribution. Some employers match after taking all contributions for the year into account, but mine contributes on a pay period basis. Any pay period that I did not contribute to my 401(k), the company did not match.

In 2008, I missed the full contribution amount by $1,000. That year, I made several changes to my contribution rate and lost track of what my rate needed to be in order to maximize my contribution.

The following table illustrates the change in 401(k) contribution limits over the past several years.

Year 401(k)
Maximum
Catch-Up
Contribution
Maximum
Allocation
2015 $18,000 $6,000 $53,000
2014 $17,500 $5,500 $52,000
2013 $17,500 $5,500 $51,000
2012 $17,000 $5,500 $50,000
2011 $16,500 $5,500 $49,000
2010 $16,500 $5,500 $49,000
2009 $16,500 $5,500 $49,000
2008 $15,500 $5,000 $46,000

Photo: urban_data

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With the new year, every dollar you earn in the United States, whether the money comes from working or from your investments, is subject to being taxed by the federal government at a level higher than last year. Recently, the IRS announced the tax rates for 2015, and while the rates are the same as last year, the income brackets have increased due to the government’s application of inflation.

Just by looking at the numbers, more of your income will be taxed at lower rates, but as the cost of living gets more expensive every year, that offset doesn’t mean much. Earning more money also means paying more taxes — but that doesn’t mean you shouldn’t be trying to earn more money. It’s more preferable than earning less money. As I’ve been reassured over the years of owning a successful business, owing more tax means you’re doing something right.

The tax brackets presented herein apply to income you earn in 2015. You may be paying estimated 2015 income taxes throughout this year, and if you are, these are the rates to use for your calculations, but the majority of readers need to worry about this table next year when completing the 2015 income tax return. For the 2014 tax returns due April 15, 2015, use these 2014 federal income tax brackets and marginal rates.

What are marginal rates?

Every year, I touch on this concept, because I found it a little confusing when I first began earning money and so much of the public doesn’t understand this. There’s a big misconception about taxes. People are afraid to earn more if it means they’re going to be “bumped into the next tax bracket.” It is not true that being in a higher tax bracket will cause all of your income to be taxed at a higher rate. The only income tax at the highest rate is the income you earn above and beyond the lower threshold for that rate.

Make sure that sinks in. You will always owe the lowest tax rate, 10 percent, on your first $9,225 of earned income if you file as a single individual (not filing jointly). You could be a CEO earning $5 million this year, but even still, your first $9,225 is taxed at 10 percent. That’s how the brackets work.

So if your total taxable income is $9,000, you owe 10 percent of that, or $900. In this case, your marginal tax rate, 10 percent, is exactly the same as your effective tax rate. You get your effective tax rate by dividing the amount of total tax you owe over your total income. This is what Warren Buffett has famously referred to when explaining how his secretary pays more tax than he does. Buffett earns a lot of income from investments which are taxed at a lower rate than earned income, and that smaller percentage affects the average — the effective tax rate for all his income.

One more thing to keep in mind is that if you are employed and your employer takes tax payments from your paycheck automatically, you pay your 2015 tax bill throughout the year. The total tax you owe when you file your tax return takes that into account. If your total tax bill is less than what you’ve paid to the federal government throughout the year, you’ll get a refund. If you haven’t covered your entire bill through paycheck withholding, you owe the government. There is always a lot of confusion about this, particularly when those in charge of policy “lower taxes.” (If taxes are supposed to be lower, why did I owe money this year after receiving a refund last year?)

The 2015 federal income marginal tax rates and brackets.

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Anyone who likes getting a look at their future tax expenses might be interested in seeing what next year’s tax brackets and tax rates will be. The IRS has now announced the official rates and brackets for 2014, although the numbers have been predicted for months because the IRS uses a simple process of inflation and somewhat round numbers to determine the brackets. Congress isn’t expected to make any changes to the tax laws this year, unlike the last several years when the question to continue Bush-era tax breaks needed to be addressed every year.

Keep in mind that the 2014 federal income tax brackets don’t matter to most people until they file their 2014 income tax returns in early 2015. That’s a long way off. But for those who pay estimated taxes for 2014 income throughout the year, the information doesn’t hurt. Chances are you’re getting ready to settle your 2013 income taxes, which will be due April 15, 2014. In that case, the rates and brackets you want to review are the 2013 rates and brackets. If you want to see how your income earned in 2015 is being taxed, view these tax brackets and marginal rates for 2015.

Before getting to the numbers, keep in mind what marginal rates are. Your marginal rate is what you pay on your last dollar of income earned. If, for example, you will earn $50,000 in 2014, your marginal rate will be 25%. That does not mean you pay 25% on all of your income.

In fact, there is a strongly-held belief that the tax code penalizes people for earning more. I’ve heard people expressing disappointment with receiving a bonus because it might push them into the next tax bracket. Yes, as you earn more money, you’ll owe more income tax (in general), but when you’re in a higher tax bracket, it doesn’t affect the tax you owe on income below that new bracket’s threshold. There’s no big jump — the higher tax rate applies only to the income you earn above the top bracket’s baseline.

(Employers have a funny way of withholding taxes on your bonus payment, but to the IRS, and in the end when you finally settle your tax bill, a dollar is a dollar whether it was earned as salary or bonus.)

There’s one instance when it does make sense to be concerned about receiving more income — when that income comes in the form of an asset that’s not very liquid. Here’s an example: In the rare circumstance you win a new car in a contest or sweepstakes, the value of that car must be treated as income. If you win a $60,000 car, you’re going to have to come up with more cash to pay taxes on that $60,000. This is one of the reasons many who end up winning these kinds of contests end up selling the prize.

The 2014 federal income tax brackets and marginal rates.

The federal income tax brackets and marginal rates have now been officially announced by the IRS. These were the rates predicted by Wolters Kluwer, CCH several months ago, based on the rate of inflation the IRS announced it would use in September. The Tax Foundation, a non-partisan tax research group based in Washington, D.C., has also shared the official information.

Rate Single Filers Married Joint Filers Head of Household Filers
10% $0 to $9,075 $0 to $18,150 $0 to $12,950
15% $9,075 to $36,900 $18,150 to $73,800 $12,950 to $49,400
25% $36,900 to $89,350 $73,800 to $148,850 $49,400 to $127,550
28% $89,350 to $186,350 $148,850 to $226,850 $127,550 to $206,600
33% $186,350 to $405,100 $226,850 to $405,100 $206,600 to $405,100
35% $405,100 to $406,750 $405,100 to $457,600 $405,100 to $432,200
39.6% $406,750 and up $457,600 and up $432,200 and up

Determining your effective tax rate.

The table above lists marginal tax rates. What might be more interesting to calculate is your effective tax rate. For example, if you’re single, you earn $100,000 in taxable income in 2014, your effective tax rate — how much tax you end up paying as a percentage of your income — will likely be much lower than the marginal tax rate of 28%. It could be half of that. After taking out the standard deduction for your income, which in 2014 will be $6,200, leaves you with $93,800 in taxable income, although there might be other deductions that apply to you.

With $93,800 in income after the standard deduction, you would owe 10% of $9,075, 15% of $27,825 (the total income covered in the second tax bracket), 25% of $52,450, and 28% of $4,450 (the fourth tax bracket up to your taxable income). That calculation results in $19,439 in federal income tax — an effective tax rate of 19.4% based on the total income of $100,000. That amount could be further reduced by any tax credits for which you might qualify. Your effective tax rate would be considered lower if you’ve had other reductions to your gross income, like 401(k) contributions.

The new standard deductions and personal exemption.

As inflation effects the tax brackets, it also affects the standard deduction amounts. I mentioned above that the standard deduction for single files will be $6,200 in 2014, an increase of $100. For married taxpayers filing jointly, the standard deduction will be $12,400, an increase of $200. For heads of household, the amount of the standard deduction will increase $150 to $9,100.

The personal exemption for 2014 will be $3,950.

What is the possibility of Congress changing the tax rates?

Congress could make a new law at any time that changes tax rates. Last year, there was a big debate that centered around the extension of certain tax cuts. The government made the decision to break the cycle in which the tax rates required a vote every year, so for once, we might be able to get through the next few months without a debate about tax rates. Given Congress’s recent proclivity for negotiating like terrorists with hostages rather than sensible adults who were elected as representatives of the citizens of this country, there’s no perfect prediction of what might occur over the next few months.

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